HSBC: Europe has reached a fork in the road

Europe has reached a crossroad, and European leaders need to
fundamentally alter the way the continent's economic and
political landscape is laid out or risk seeing continued unrest
and a potential domino effect of more countries choosing to leave
the European Union in the coming years, according to HSBC.

In the bank's quarterly report on the state of the European
economy, Karen Ward and Fabio Balboni at HSBC argue that the
continent's leaders, particularly those in Brussels, have two
options.

They can continue to "muddle through" with economic policies that
are providing steady but unspectacular growth and possibly
helping to fuel political discontent, or they can "rethink the
current direction and consider changes" and fundamentally alter
the continent's direction.

Here is the key extract from HSBC's research (emphasis ours):

"The problems run deep. Growth is still anaemic, unemployment in
parts of the periphery still painfully high. Part of society is
not doing well out of globalisation, while ageing populations
fear they will not get the pensions and healthcare they were
promised. Many EU voters can't accept sending payments to other
parts of the EU, or being given bad news about their retirement
expectations by Brussels.

"Economists are starting to realise that our solution to
the problem — investing in skills and productivity to maximise
both employment and potential national income to meet pension
promises — may not be politically deliverable. It's too
long term. The populist alternative — bigger hand-outs,
protectionism, nationalism — is more enticing."

"And so the EU now appears at a fork in the road. It can continue
to do more of what it's doing today. QE helps governments
continue to muddle through. Meanwhile, officials at the European
Commission and the ECB continue to make plans for closer union —
capital markets, banking, political and fiscal, all of which are
encountering more and more opposition at the national level.

"Or it can take this as an opportunity to rethink the
current direction and consider changes needed to improve
sentiment towards the EU and help fix some of the underlying
economic problems. Just as capital controls are
sometimes needed to control the flow of money across borders, it
might be worth reconsidering whether the complete free flow of
labour is politically possible in a world in which globalisation
is being rejected by parts of society."

The domino effect

HSBC cites evidence of referendums in Hungary and non-EU member
state Switzerland, which showed that many people are fearful
about having limited control over immigration in their countries,
as evidence that, as it notes "globalisation is being rejected by
parts of society." Capping free movement in some way could be a
way of appeasing those who oppose globalisation and potentially
stemming the tide of populism.

While the bank is keen to argue that the EU should use Britain's
vote to leave as a catalyst for change to the way Europe's
political and economic systems functions, it is not hopeful that
Brussels will do so anytime soon. Here's the bank's conclusion
(emphasis ours):

"Essentially, we are assuming that the EU continues to
muddle through on the back of more QE and bigger
deficits. But this may not be sustainable. We hope
instead that the Brexit vote becomes a catalyst for positive
change. The EU might be wise to do this for its own sake.
Resisting it may mean the UK is not the only domino to fall in
the years ahead."